With the 2011 harvest season just around the corner in many parts of the country, custom forage harvesters are likely to find many of their dairy-producer customers a bit more upbeat than they were a year ago.

Prospects for improved milk prices underpin the optimism. By many estimates, the U.S. all-milk price this year could climb into the $19-20/cwt range during the first half of the year. For the entire year, most forecasts are calling for the price to average around $17.50/cwt compared to an average of $16.20/cwt for 2010.

By the end of the year, prices could retreat to $16-17/cwt, according to Bob Cropp, professor emeritus of ag economics at the University of Wisconsin.

“While that would be a pretty large drop-off from the high, dairy producers would still be able to cash flow,” says Cropp. “They could at least pay their feed bills and hang in there.”

Just three months ago, Cropp notes, many industry forecasters were predicting the all-milk price could sink to around $15.50 by the end of March.

Most of those projections were based on the fact that milk production was pushing upward during the second half of 2010 as dairy farmers tried to generate more income to offset losses they suffered during a disastrous 2009.

What’s changed since the start of the year is that, while milk production is still on the upswing, demand for milk and dairy products has also improved. Cropp notes that domestic sales of cheese and butter “have been quite robust,” even though prices for those products remain high. Dairy product exports, while not likely to be as strong as in 2010, are also doing well.

At the same time, world milk supplies are likely to show only a small increase, due to weather-related problems in Australia and New Zealand. Those two countries account for roughly 40% of world dairy product trade. Also likely is increasing demand for dairy products worldwide, brought on by overall improvement in the global economy.

The net result, according to Cropp, is that milk buyers are anticipating considerably tighter supplies of milk and dairy products in the months ahead and have been aggressive in bidding up prices.

“There’s some psychology at work in the market,” he says.

The question on the minds of most dairy producers, of course, is how long prices will stay up. A variety of factors, including the possibility that higher dairy product prices will create demand resistance among consumers, will likely play a role. But Cropp says milk production trends are the key.

“To hold prices at the levels being indicated by the milk futures market, production will need to slow down from what has been occurring for the past few months,” he says.

And, while some forecasters believe sharply higher grain and hay prices could begin to curtail milk production soon, Cropp cautions that’s far from a sure bet. “This year’s growing-season weather is going to be critical,” he says.

On one hand, some long-range weather forecasts indicate that the Corn Belt could be in for a widespread drought this summer. That would take feed prices higher.

“If corn were to go to $8/bu, we’d see some (dairy farm) liquidations,” Cropp says.

But it’s also possible that the weather will be excellent, taking crop supplies and prices in the opposite direction. “The only thing you can say for certain right now is that there’s a lot of uncertainty on the feed side.”

Dairy producers in Western states, who tend to rely more on purchased feed than their counterparts in other regions, could be particularly vulnerable to an extended and sharp feed-price runup. Steadily rising corn, soybean and forage prices are worrisome for producers, even with milk prices improving, points out Eric Erba, senior vice president of California Dairies, Inc., that state’s largest dairy co-op.

“Dairy producers who weren’t expecting (feed price increases) just a few months ago are definitely paying the price now,” he says.

Erba and Cropp say changing relationships between lenders and their dairy customers pose another challenge for dairy producers in 2011. Many lenders are now encouraging, if not requiring, customers to use risk-management tools (forward contracting, hedging, etc.) for grain inputs and milk prices, Erba points out.

Cropp says that’s true for dairy producers in other regions, as well. “If you’re highly leveraged, the lender is going to want you to do that,” he says. “If you’re not willing to do it, you’re probably not going to get the loan.”

Bottom line, he says, is that lenders have been forced to become more cautious after the industry’s dramatic downturn in 2009.
“In general, they’re requiring more financial information – balance sheets, cash-flow projections, etc. – than in the past. They want customers to have their financial books in order. Overall, that’s good. It will make dairy farmers better business people.”